This week, I wanted to go into more detail about how we construct your portfolio of loans, and how this relates to achieving our target product returns.
Before we begin, here are a couple of useful definitions:
Target return: The annualised return we predict an investor will achieve, based on our current view of the whole market and expected defaults
Projected return: An annualised prediction based on an individual investor’s portfolio and their specific microloans’ actual performance
At Zopa we recommend that all investors begin with a minimum of £1000. This is because, when you invest though Zopa, your money is broken down into microloans (of around £10) and matched to borrowers using an automated matching process. This creates a blend of diversified microloans across many different borrowers.
So: how do we build your portfolio?
We look at three things:
The projected return of each individual microloan
Our matching algorithm (the set of rules our calculations follow) works to give you a blend of microloans which are selected to provide a projected return as close to the target return as possible.
In February 2017, 92% of investors with at least £1,000 in Zopa are achieving projected returns within 0.2% of our target return.
The risk market of the loan customer
When we determine the interest rate a customer pays for a loan we assign them to a risk market (based on a wide variety of factors including their credit history). This means different borrowers pay different rates of interest depending on their circumstances: there isn’t a set interest rate per risk market.
Investors lending through Access and Classic draw their loans from risk markets A*-C; Plus investors can be assigned loans from two additional, higher risk markets (D and E). In your loan book, you can see the risk market each microloan is assigned to and the investor interest rate that you are scheduled to receive from each borrower.
For example an investor in our Plus product would hold loans across all 7 markets (A*-E).
We recommend a minimum investment of £1,000 to spread your money across different borrowers to achieve the target return. This is mandatory for investors in Plus, and recommended for Access and Classic.
Our algorithm is set to ensure that no more than 1% of your portfolio is lent to one person, limiting your exposure to any individual borrower. So an investor with an initial investment of £1,000 will typically start with 100 microloans.
Once matched we monitor and update
As we build your portfolio of loans, we continue to closely monitor it to ensure it tracks as closely to the target rates as possible
We have a dedicated team of risk analysts who closely monitor loan performance and use this to update predictions of how similar loans in the future may perform. Our marketplace is dynamic, and this aims to ensure that your projected returns continue to be accurate as the environment changes.
For a big picture view of how loans are performing, the team provide regular updates on projected returns and actual loan performance.
Every Friday, in your Weekly Update we include average projected returns on all loans matched by Zopa over the last 4 weeks. These numbers vary week on week because individual loan books are constantly evolving, but are consistently close to our target rates.
As always, our Client Services team are just a phone call or email away to answer any questions you have about your Zopa investments.
Remember: when you lend your money your capital is at risk and is not protected by FSCS. Our risk statement has all the details.
Andrew Lawson is Chief Product Officer at Zopa.
Photo credit: Jason Briscoe, New York, 2016